Also known as "distributed ledger" technology, blockchain uses
complex cryptography and a wide network of duplicated ledgers to
let people transact directly with one another online without
going through a middleman.

Transactions must be signed off on by both parties and the record
cannot be changed once a deal completes.

Finance firms believe the technology has the potential to strip
out a huge amount of cost by speeding up transactions and
removing the need for people to work through a clearing or
settlement house.

But Citi warns that there's a risk the technology could also
reduce banks to just "dumb pipes" — simply infrastructure
providers who let more nimble
fintech startups funnel money around, deal with clients, and,
as a result, take home the bulk of fees.

In this scenario, it is the fintech businesses who can make the
best margins, given their client relationships, at the expense of
big banks.

Citi's Keith Horowitz writes in a recent "Citi GPS" note:

A report by the World Economic Forum released in June 2015 said
“decentralized systems, such as blockchain protocol, threaten to
disintermediate almost every process in financial services”.

One argument is that as the technology firms develop blockchain
solutions, there is a risk that banks could be relegated to
becoming “dumb pipes,” forming only the infrastructure through
which money flows, but with most of the benefits accruing to
service providers.

This scenario represents an occurrence similar to what happened
with the telecom industry, where the rise of the Internet allowed
for competition in what was formerly a highly regulated industry.
Innovations like VoIP enabled tech companies like Skype to
benefit from the existing physical infrastructure.

Horowitz isn't the only one to compare the current
financial-technology boom to the overhaul of the telecoms
industry in the 199os.

Juan Lobato, cofounder of online business-finance startup Ebury,
told BI in November: "Technology is disrupting all areas of
finance. I was quite active in telecoms in the 1990s. The same
thing happened there — new technology enabled things to be done
very differently with a very different cost structure."

While Citi flags the risk that banks could be sowing the seeds of
their own downfall with blockchain, the bank doesn't actually
think they'll become just "dumb pipes."

It presents three arguments as to why, two of which hold up and
one that seems a little suspect.

First, Citi says "banks have a very valuable asset in the form of
their large identifiable customer-base." That's true. It's much
harder to win new customers than it is to keep them, and the
banks will work very hard to keep their customers.

Secondly, banks have "unmatched experience when it comes to
handling burdensome financial regulation." Again, that's
certainly true. Many fintech companies benefit from the fact that
they are currently unregulated or too small to face any
meaningful regulatory burden. But if the sector is to thrive and
grow it will have to come to terms with regulation — something
banks have been doing for years.

But Citi's third argument is that "banks benefit from a
relatively strong track record of safekeeping assets, and
therefore have earned a certain amount of trust and credibility."
Given that banks are still fessing up to billion-pound fines
almost weekly, the words "trust" and "credibility" are probably
not the first you'd associate with large banks these days.